Fed’s Evans: Weak Outlook Calls for Continued Strong Fed Action

DENVER –A key Federal Reserve official argued forcefully Friday for the central bank to continue providing support to the economy, saying the improving economic outlook is unlikely to bring much relief on the unemployment front for some time.

Given the outlook, “substantial policy accommodation continues to be warranted,” Federal Reserve Bank of Chicago President Charles Evans said.

“We need to keep short-term nominal policy rates low for an extended period,” he said, describing the bond-buying program as “a complementary policy tool in this regard as it solidifies our commitment to keeping short-term rates low for an extended period.”

Collectively, “our policies are striving to achieve this appropriate accommodation,” the official said.

Evans will take on a voting role on the interest-rate-setting Federal Open Market Committee at the next meeting. His views show him to be firmly in alignment with Chairman Ben Bernanke and other central bankers who believe that even as economic momentum builds, joblessness will be a problem for a long time, which calls for central bank assistance to help improve the situation.

Evans spoke in the wake of testimony by Bernanke on Friday that showed little wavering on the commitment by the Fed to buy $600 billion in Treasurys by the middle of this year. Both officials followed the release earlier in the day of the December jobs report, which was mixed in that job gains underwhelmed, but the unemployment rate fell more than expected. Most on Wall Street now expect the Fed to continue with its controversial policy.

Evans was speaking before a gathering here before the ASSA-AEA Conference. His comments came from the text of a speech prepared for delivery there.

After his formal speech, Evans said that he was “open minded” about the bond buying program and explained the Fed would monitor the effort to make sure it was consistent with economic developments. But even so, he reckoned “the hurdle is pretty high” to change the path the Fed is now embarked upon.

The policy maker noted that in its current incarnation the bond buying effort is not proving as effective as it did in its first iteration, but he said that may be because financial markets are more healthy than they were awhile back.

Evans also said that the interest the Fed now pays banks on reserves could be changed, given that financial institutions have parked some $1 trillion in cash at the Fed that could possible be lent out. “It’s a policy which during more normal times would help firm up the fed funds rate,” Evans said, but “at the moment, it is question whether or not some change in the policy might be helpful.” Evans said he expects bank lending to improve along with economy.

In his formal remarks, the official offered a mixed view on the economy. “The pace of recovery has been disappointing,” Evans said. He noted that recent data have been “somewhat stronger,” but added “they do not yet point to the kind of robust, self-perpetuating recovery that we need in order to close today’s large resource gaps within a reasonable amount of time.”

Evans expects U.S. gross domestic product to rise by an average of 4% over 2011 and 2012, but added that rate “is only modestly higher than the growth rate of potential output and thus represents a quite muted recovery given the severity of the recession.” Such a growth rate “is not strong enough to reduce unemployment significantly within a reasonable time frame; it would likely result in the unemployment rate remaining in the neighborhood of 8 percent at the end of 2012.” On Friday, the unemployment dropped to a still high 9.4%.

Evans sees no threat of higher price pressures. “In light of stable inflation expectations and the large resource gaps I previously mentioned, there is little pressure for inflation to move much higher in the current economic environment,” he said. “Inflation is likely to remain well below 2% over the next year or two.”

Evans repeated his view that the economy is stuck in a “liquidity trap,” saying, “Spending is being held back by extremely cautious behavior by businesses and households.” The Fed needs to create the conditions to set this money loose, he explained.

The policy maker also said inflation measures will “signal the appropriate time to remove policy accommodation,” adding, “Should our strategy prove to be a little too successful and inflation rise faster than we expect, we have the tools to tighten quickly as needed.”

Evans downplayed the rise in bond yields that has followed the start of the asset-buying program, even as he acknowledged “these purchases are aimed at reducing long-term interest rates.” The official explained “other events have intervened” and “it is reasonable to attribute a portion of this increase [in yields] to lower probabilities of deflationary tail events.”

After his speech Evans described the December jobs report, with its smaller-than-expected rise in hiring coupled with a welcome fall in the unemployment rate, as “pretty complicated,” in a release that “plays out in many different ways.”

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